Apple Attracts New iPhone Fans as Existing Owners Await Upgrade

Published on February 01, 2017.

The iPhone 7 Plus, iPhone 7 and iPhone SE. Credit: Apple

Apple Inc. attracted a swathe of new iPhone customers over the holiday period, auguring well for a more significant upgrade to its flagship product this year -- and the services revenue that these devices are increasingly generating. The shares climbed to the highest price in more than 17 months.

Existing iPhone users upgraded to the latest iPhone 7 models at about the same rate as the iPhone 6S a year earlier, Apple CEO Tim Cook said in a conference call with analysts. Yet Apple still managed to sell 3.5 million more phones in the three months ended Dec. 31, indicating growth was driven by new customers.

The iPhone 7 represented a modest update to its predecessor, the 6S, adding water resistance, an improved camera, battery life and processor while retaining similar styling. Expectations are mounting for a more significant upgrade to Apple's flagship product later this year, which is the 10th anniversary of the iPhone's launch. That may persuade more existing iPhone users to open their wallets for the next model.

"When we're able to innovate with new generations of products, clearly that plays a role in the upgrade rate," Chief Financial Officer Luca Maestri said.

Apple's research and development budget is growing apace, hinting at new innovations or products in the works. R&D spending jumped 19% to $2.9 billion in the first quarter.

Apple reported total revenue rose 3.3% to $78.4 billion, with earnings of $3.36 a share, in the holiday quarter, exceeding analyst forecasts. The shares gained 6.7% to $129.50 at 2:10 p.m. in New York, the highest value since July 2015.

Samsung Electronics Co. recalled its flagship Galaxy Note 7 smartphone in September after a flaw that caused some batteries to burst into flames. That reduced competition in the market for large, high-end smartphones and likely helped attract new customers, according to New York-based BTIG analyst Walt Piecyk.

"Once they get you in their ecosystem, they've got a far better shot at getting you to buy another one of their phones," Mr. Piecyk said. "If anything, the fact that it wasn't stickiness and services and upgrades makes you feel better about future growth."

Americans are taking longer to upgrade their smartphones, partly because wireless carriers have phased out plans that offer discounts for new devices every two years. That puts more pressure on handset makers to find new customers -- something Apple pulled off in late 2016.

Last year, Apple suffered a rare year-over-year revenue decline, as iPhone sales tumbled, particularly in China, where competitors such as Oppo and Vivo introduced cheaper phones with similar performance. In the first fiscal quarter, sales in mainland China grew, excluding the effect of a strong U.S. dollar, Mr. Cook said.

Mr. Cook's response to last year's sales decline was to push more services, such as Apple Music, the App Store and iCloud. These businesses are more profitable than iPhones and iPads, and they increase the chances customers will buy future Apple gadgets because users' apps and data are tightly woven into the company's operating systems.

Services revenue grew 18% to $7.2 billion in the most recent period. Apple said it aims to double the annual total to more than $50 billion by fiscal 2021.

"The App Store is going to be a significant driver of growth," CFO Maestri said. "A lot of it comes from the fact that our installed base of devices around the world continues to grow very well."